NAIC Committee Votes to Forbid Indemnification of Auditors by Their Mutual Audit Clients

December 18, 2001

In a firm gesture that told the accounting profession to face its responsibility in annual audits of mutual companies, an NAIC committee with jurisdiction over such audits has voted to forbid indemnification of auditors by their mutual audit clients.

The NAIC/AICPA Working Group’s unanimous vote earlier last week and a superior committee’s affirmation later of that vote are almost certainly the end of the practice, in which certain Big Five audit firms have sought or demanded indemnification from mutual insurance clients for claims or damages resulting from management’s misrepresentation. The votes occurred during the NAIC’s winter meeting in Chicago.

NAMIC had complained to the NAIC about the practice, which gives undue advantage to audit firms when disputes arise over responsibility for inaccuracies in financial statements.

Indemnification of auditors is prohibited by the Securities and Exchange Commission for all publicly owned companies, including insurance entities. The inequity between auditor-client relationships for mutual and stock insurance companies was clearly a factor in the NAIC decision to forbid the practice.

Part of NAMIC’s complaint to the NAIC was that indemnification of the auditor compromises the auditor’s independence. A large element of opposing testimony given by Albert Reznicek, a Deloitte & Touche partner who represented the American Institute of Certified Public Accountants, was that indemnification does not diminish auditors’ responsibility to follow generally accepted audit standards, which govern conduct of audits. Four other Big Five partners argued earlier against the proposed ban before the working group adopted it.

William Boyd, NAMIC’s financial regulation manager, who had proposed prohibition of auditor indemnification, told the NAIC/AICPA Working Group, “The accounting profession is an honorable one. We did not come here to accuse the profession of any instance of misfeasance or malfeasance.”

“Auditor indemnification is the result of the potentially adverse relationship between auditor and client. But such a situation neglects an important audience, and that audience is the user of financial statements. … In our first request to this working group we asserted this matter is about auditor independence and that auditor indemnification compromises auditor independence.”

The ban on auditor indemnification unanimously approved by the NAIC/AICPA Working Group was done by an amendment to the NAIC’s “Model Regulation Requiring Annual Audited Financial Statements,” or “Model Audit Rule.” That amendment was affirmed by the NAIC’s Financial Condition (E) Committee, again on a unanimous vote.

Although the amendment must also be approved by the NAIC plenary committee reversal of the subordinate committees’ unanimous votes would be very improbable.

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